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There are several factors that are considered when selling a real estate
note: Although most notes are usually discounted,
we do not have a standard or fixed discount rate. Each note is reviewed and
priced on its own merits.
The value of the note is roughly based on the down payment, interest rate,
payment amount, and term, as well as the buyer's credit rating and payment
history. Additionally, the type, condition, and value of the property are also
taken into consideration.
The sale of your note never changes the interest rate of your mortgage note,
the monthly payments or any other term of your mortgage contract.
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Time Value of Money
Your real estate note will never be worth more than it is today!
Money generally decreases in value over time. Today you can
buy less with a $20 bill than you could five years ago. That is the reason why a
lump sum today is worth more than a lump sum 5 years from now. It is called
the time value of money. With low interest rates, many investors are buying
privately held mortgage notes as relatively safe investments.
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Market conditions
Interest rates can fluctuate creating bull and bear markets in the Stock market. Real estate notes are long-term instruments and are also
affected by interest rates. Here is an example:
You own an 8%, 30 year real estate note. Interest rates are down and are hovering around 4.5%. Your note is appealing to investors, because
it is offering a return bigger than the return at prime rate.
If interest rates shoot up, there is a point where other instruments will be more appealing to investors than real estate notes. In this
case, the value of the real estate note could go down, and your 8% note would not be as appealing as it was before.
The opposite could also be true. An 8% note would suddenly be more appealing if the interest rates go down to 2%. However, this is a general
rule, as there are other factors which would also need to be considered. Market conditions matter.
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Credit record of the Payer
The credit history of the Payer could affect considerably the value of a real estate note. For example, if the Payer had B credit three years
ago, but has been unemployed over the last year and has some collection accounts on credit cards and a couple of tax liens, the credit rating may now show D
credit.
Even though the Payer may be making timely mortgage payments, risk has now become a factor for any investor interested in purchasing the note.
The note would go down in value and/or appeal.
The opposite may also be true. If the Payer's credit improves, your note may become more appealing, relatively speaking.
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Equity on the Property
This applies to both Residential and Commercial properties. Most real estate properties appreciate over time. But occasionally the real
estate market gets into a slump and properties go down in value 10, 20, 30% or even more.
If last year you issued a 90 percent loan to value (LTV) mortgage on a property that just lost 30% of its value, your note has gone down
in value, too. In fact, in this example, the note balance is greater than the equity on the property!
Note buyers generally prefer a large equity position on the property to cushion against sudden slumps. Many buyers consider a 10-15% equity
or less a risk, and either stay away from these notes or price them accordingly. Equity is very important.
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Seasoning
As a note is being paid off, the Payer builds up his credit and becomes credit worthy in the eyes of the note buyer. A note that is at least
1 year old is considered a seasoned note by most buyers. Many note buyers either stay away from unseasoned notes or price them accordingly.
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Note holder's relationship to the Payer
Over the years, we've seen that the closer the relationship between the note holder and the payer, in the event of a fractured relationship,
the higher the risk for a situation that could lower the value of a note.
Sometimes employers hold notes for employees. If the employee is dismissed, the value of the note may go down. Also, sometimes spouses hold
notes for their significant others, where the value of the note may be affected if there are marital problems.
We are not advocating that you should never hold a mortgage for a loved one or for an acquaintance. We would simply like you to be aware of
all these factors.
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Risk
Most note holders created their notes for individuals or businesses that would not have qualified otherwise for a traditional loan. For
most lenders, these payers are considered 'risky'. Any investor when buying a seller-financed real estate note assumes that extra risk and is compensated for
assuming on such risk.
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Liability
This applies mostly to commercial properties, but also encompasses residential properties as well. If the building you're holding a
note on has, for example, a Dye Maker and a Night Club as tenants and somebody just found some old rusted leaky tanks on a storage facility on the rooftop, you
are facing a large liability risk and your commercial note could lose value.
But you don't own the building, right? It doesn't matter. The perception is that the dye maker could generate some environmental liability;
the Night Club could become part of a drug or money laundering ring.
As a result, the building owner (payer) could become embroiled in a multi-year investigation/lawsuit/litigation, which could render
him insolvent. The payer may still pay every month on time, but the note may go down in value, regardless.
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